Breaking the bottleneck: will investors cash in on the transition materials super-cycle?

The next five years will be a busy period for renewables operators. By the end of the decade, the IEA expects 4600GW of capacity additions. That’s twice the scale of the past five years.

Optimism around the investment opportunity often surrounds the building blocks – solar farms, wind turbines, battery storage and distribution.

Lurking in the shadows is the opportunity to profit from the ingredients – the materials that feed into renewable energy technologies. Think lithium and cobalt in batteries, copper in grids, silicon in solar panels.

The market for these materials now sits at a critical junction. As the IEA’s latest World Energy Outlook notes, supply chains for transition materials are incredibly concentrated. One player – China – controls on average, 70% of the market for these materials.

Governments across the world have taken note. In a bid to avoid dependency down the road, they're pushing for diversification. For the plan to work, investors need a reason to buy-in. Can the diversification push translate into long-term, risk-adjusted returns?

Structural shift

To say that investors are bullish on transition materials is to state the obvious. After all, structural shifts in industrial technology tend to have that effect. So, commodity markets have been here before. The metals boom in the 1970s or the demand unleashed by China’s industrialisation at the turn of the century, for instance.

History of course, could repeat itself. Fidelity International, an asset manager, is making the case that this time is different. A commodities super-cycle, they’re calling it.

“We think we are entering a new super-cycle, due to the secular net zero transition the world is undergoing, driving demand for transition materials”, says James Richards, a portfolio manager for Fidelity’s Transition Materials Fund.

A paper Richards and his colleagues authored, predicts a commodities super-cycle - a bull market spread over anywhere between 10 - 30 years.

Concentration risk

So long as the transition progresses along the IEA’s projections and the ingredients of technologies don’t change all that much, the super-cycle theory has legs. To go from theory to investment decisions, however, requires an important caveat – supply chain concentration.

History is filled with examples of concentrated supply chains becoming sources of political meanovering by those in command. ‘Weaponised interdependence’, as academics Henry Farrell and Abraham Newman termed it in a book about that history.

While this is a source of risk, Fidelity’s thesis reckons the contrary – where there is risk, there is also opportunity.

“Concentration and potential production bottlenecks are part of what underpin the investment opportunity; higher prices are needed to incentivise production and meet likely demand. As we have seen in markets like copper this year with US tariffs, politics does have the potential to cause big, short term price changes”, Richards explains.

The response, outside of China, has been a last-minute push for diversification. Oliver Hextall, who also manages Fidelity’s transition materials fund says diversification is an investment signal.

“We’re seeing this with rare earths, where the US government is pressing hard for increased domestic production as well as taking direct equity stakes in a US rare earths producer to try to encourage this”, he told Net Zero Investor.

“Tight supply in many transition materials will be as important as strong demand in driving price gains”, he adds.

Investor interest

Institutional interest in listed equity strategies that capture transition materials, both Fidelity managers report, is on the rise. Long-term return prospects aside, Richards points out another driver of investors paying attention to commodities super-cycles: inflation.

“For a variety of reasons, we look to be entering a macroeconomic environment of structurally higher inflation. Commodity equities have a good track record when it comes to hedging against this – whether you look at the 1970s, the 2000s, or the last few years”, he says.

Yet, if asset owners were to tap into the super-cycle, history suggests returns are unlikely to ubiquitous – not all producers will stand to gain. Picking winners and backing the securities they issue is likely to become routine pre-investment exercise.

In a long-term transition materials cycle now sitting at a turning point, asset owners will know that more immediate shifts in prices, production and innovation will need to be responded to. In what is turning out to be an opportunity with capricious risks, they’d want a manager capable of keeping up.